Sunday, August 24, 2014

Federal Reserve "Dual Mandate" of Full Employment and Price Stability is Likely Unconstitutional and Radically New

“Justice? - you get justice in the next world, in this world, you
have the law.”

William
Gaddis JRTo most the following clearly outlines a "dual mandate", a long running permanent foundation stone of the powers mandated
to the Federal Reserve by Congress, an ubiquitous feature of monetary policy:

“Consistent with its statutory mandate, the Committee
seeks to foster maximum employment and price stability. Currently, the
unemployment rate is elevated, and measures of underlying inflation are
somewhat low, relative to levels that the Committee judges to be consistent,
over the longer run, with its dual mandate.”

November 2010 FOMC Statement.

From then on it was posted in one way or another in every FOMC Statement:

“Consistent with its statutory mandate, the Committee
seeks to foster maximum employment and price stability. The Committee expects
that, with appropriate policy accommodation, economic activity will expand at a
moderate pace, with labor market indicators and inflation moving toward levels
the Committee judges consistent with its dual mandate.”

July 30, 2014 FOMC Statement.

But the current use of "dual mandate" is not a legacy constitutional keystone empowering the Fed but is a radically new interpretation of the Federal Reserve Act perhaps now cynically used by Yellen and company. The current use of "dual mandate" is unconstitutional and is at odds with the academic literature on monetary economics and a "ruse" so as to allow the Fed to make economic policy that they are excluded from doing so - thus its unconstitutionality. The “dual mandate” used in the Statement, the official lawful communique by the Federal Reserve, a
radical ambitious (mis)interpretation of the law so as to justify the current focus of the Board of Governors, as led by the Chair, have on employment.

This citing of “dual mandate” with "maximum employment" as used is necessary to justify the current Odyssean Fed
and the principles of “forward guidance”.
It empowers the Fed to subjectively and secretively define what is “maximum
employment” – now a slippery qualitative and complex mixture of 19 distinct
measurements of employment characteristics, the LMCI, and a radical de-emphasis on the unemployment rate
(UER-3), especially as the rate falls to levels that mocks the Fed.

The Fed's has justified their power rests on the “dual mandate”, as defined by the Fed and by the Board of Governors, specifically the Chair, deploying a English/Alvarez/Bernanke invention of the centrality of employment as the mainstay of "communicative" policy. But this use of the dual mandate is not a consensus of Federal Reserve
staff, nor with the staff at the Board of Governors.

There is deep concern within the Fed that the
emphasis on employment, now qualified by the economic intuition of Yellon, is an
incorrect interpretation of the law and is either a theoretical non sequitur or a deliberate academic falsehood, a ruse.

Empowerment for current Fed forward guidance monetary policy rests upon the constitutionality of the “dual mandate”, provided it does not cause
undue inflation, on a subjective constantly changing definition of “full employment”.

This stress on employment is not reconciled with the Federal Reserve Act original intent
nor by the amendment of 1977 and 1978.
The 1946 Employment Act does grant the President, or rather charges the
President to table policy to Congress to provide “maximum employment”, and the
1978 Act does request the Fed to coordinate with that Executive defined
policy. But it is clear if the President
does not table such policy and Congress does not insist upon the Executive to
do so, the Fed is not to intercede or fill in the vacuum with monetary policy aimed at changing employment status.

If the “dual
mandate” now offered at the end of a paragraph sites a mandate
the Fed does not have granted by Congress, wording starting with “Consistent with its statutory mandate”, is
a legal ploy by the Fed to end that paragraph with seemingly a repeat of the “statutory”
with “dual mandate” but now, unlike the language of the statue it states “maximum
employment”.

Thereby
the Fed “switching” the statutory mandate of conducting monetary policy "commensurate with potential production” with
“maximum employment” is to switch a forward view of not impeding potential production being reached, and thereby the resulting in perhaps the sweet spot of “maximum employment”, with the Fed current "extraordinary" proactive
current policy that has “maximum employment” as the only economic objective. This is not the law.

Since
this cannot have gone unnoticed by the Board of Governors, I am certain that
there has been discussion at the highest levels with the involvement of Alvarez etc, so the use of "dual mandate" is a deliberate redefinition of the law by the Fed – and is therefore unconstitutional.

The
ability to show there can be a reasonable argument in that “dual mandate” is an
incorrect read of the law, that the debate can even be had by thoughtful people
both in the Fed and outside, should cause great concern.

If in fact the argument prevails that the
wording “dual mandate” is an incorrect read, perhaps to serve a
political agenda by certain ascendant groups in Congress, will be devastating for the Fed and likely ends with Yellen’s dismissal.

That will take place if, though well-meaning in terms of public
service, the “dual mandate” does not work and then it will be easily shown it is a legal ruse justifying a radical progression of the Fed to write macroeconomic
policy for which they do not have the mandate or the constitutional power or power to do so.

What
further compounds this problem and heightens risk is that the replacement of Federal Reserve Act "production" with many facets, with just employment is an unproven and keenly debated thesis which
involves the Phillips Curve, wage stickiness and many other confusing and
unknowable economics.

Employment has
been massively disturbed by a once per century economic event, a solvency event, and it is not even known why unemployment rose as it did and why it is dropping
in the fashion it is now. The various ways of describing unemployment are also
not calibrating with “demand side” of
qualified labor showing an extremely strong if not on the edge of a bubble economy
while unqualified workers and many of the supply side metrics of labor show perhaps a
lack luster economy.

This is
not the time for the Fed Board of Governors and FOMC to
rewrite law with unproven radical theories of how monetary tools connect to real world outcomes.

Yet the
public and strangely almost all those in the financial industry are uncritically
accepting of the Fed’s radical rewrite of law.
Most have the adamant view that “dual mandate” is written on bedrock and
are derisive or dismissive when someone points this out. That they "know" the dual mandate was the intent of Congress and it has always been with us, at least since 1977.

The reality is that before the
November 2010 Statement, the dual mandate of employment and inflation was an abstract or descriptor of what the Fed
did, a shorthand even, and was never considered the statutory mandate.
“Dual mandate” was economic slang,
describing what the Fed would
monitor and consider but not the statutory
mandated objective. It was the “effect” and not the “cause”. The original clause was a different “dual” –
that of inflation and low long term interest rates. The title sentence of the
Federal Reserve Act to this date does not even mention employment but states:

“An Act To provide for the establishment of Federal reserve banks, to
furnish an elastic currency, to afford means of rediscounting commercial paper,
to establish a more effective supervision of banking in the United States, and
for other purposes.”

The Federal Reserve is not
to write economic policy but first and foremost provide a Bagehot/Kindleberger
central authority that provides lender of last resort services and maintains liquidity
through the acquisition of assets from the private sector. This is the most inspired public policy since
Hamilton created the US Treasury and national fungible debt. And of course it
is why the USA did not enter into depression in 2008. But once that courageous and wonderful duty
was implemented for the nation, the Fed – likely for a myriad of reasons –
decided they must focus solely on “for other purposes” as they interpreted in the fly.

The first Congressional act
that dealt specifically with employment, in 1946, did not even mention the Federal
Reserve but the President. There
was great concern that after the massive Keynesian stimulus of WWII remedied
the crazy tightness of FDR working in coordination with the Federal Reserve tightening, the new President Truman with his reputation of being a “Blue
Dog” and fiscally tight, was charged by Congress to deal first and foremost
with employment. It was thought that
returning soldiers returning to a peace time footing would
throw the economy into depression, once again.
Therefore it is in error to cite the 1946 act as having anything to do
with the Federal Reserve “dual mandate”.
This is the popular view error was summed in a Washington Post letter to refute
George Will taking similar lines to what I am stating here. Since the writer is Ken McLean who was a
staffer in the writing of the 1977 and 1978 amendments to the Federal Reserve
Act, it is thought to have authority and set the record straight. McLean writes:

“The 1977
legislation referred to by Mr. Will was the Federal Reserve Reform Act, which
among other things called upon the Fed to conduct monetary policy so as to
"promote effectively the goals of maximum employment, stable prices and
moderate long term interest rates." These goals are substantially
equivalent to the long-standing goals contained in the 1946 Full Employment
Act. The goals of the 1977 act were further affirmed in the Humphrey-Hawkins
Act the following year.” (WP
November 25 2010)

This is either at best in
error, or worst disingenuous as nothing that transpired or said by Congress, even to
date, supports his statement. To cite
the 1946 act is either an old man with a fogged mind or simply bunk. The 1946 act has nothing to do with the Federal
Reserve Act and the the Federal Reserve amendment of 1977 citing of the 1946 act in 1978
clearly has employment as the effect that increased production would bring
about, among other economic variables.
McLean also takes the wording of maximum employment out of context, not
mentioning the preceding language.

The key
and entire language is in Title 12 Chapter 3 Section 225 (a) which was changed
with the 1977 amendment, a change that
was 64 years in the making, with the addition of the term “maximum employment”:

“The Board of Governors of the Federal Reserve
System and the Federal Open Market Committee shall maintain long run growth of
the monetary and credit aggregates commensurate with the economy's long run
potential to increase production, so as to promote effectively the goals of
maximum employment, stable prices, and moderate long-term interest rates.”

It is important to note where employment appears in regards to or dependent on what. The statutory mandate is to “increase production”. “Maximum employment” is the intended results of “increase production” and explains why Congress is instructing the Fed to increase production. To have the Fed to assist or allow administrations policy for the country to reach potential
production is the entire mandate, and it is assumed that maximum employment will be the
end results, which by production growth the Fed "promotes" for the long run.

The
following year Humphrey-Hawkins Act elaborated further on this intent and “finding
of Congress” and clearly shows the non
policy making role of the Fed by adding
a reporting section 225 (b), which by listing what Congress wants reporting on
shows the placement of employment in this intent:

“(b) Congressional Report.The Board shall, concurrent with each
semi-annual hearing required by this section, submit a written report to the
Committee on Banking, Housing, and Urban Affairs of the Senate and the
Committee on Banking and Financial Services of the House of Representatives,
containing a discussion of the conduct of monetary policy and economic
developments and prospects for the future, taking into account past and
prospective developments in employment, unemployment, production, ,investment,
real income, productivity, exchange rates, international trade and payments,
and prices.’

Clearly employment is
only one of the several factors of “the long run potential to increase production”. There are many variables,
employment being only one of the variables.

Furthermore the 1978 Act
has a preamble a “finding” of Congress which shows the limits and the
expectations of how the Fed was to act in this system and with whom:

“and by improved coordination among the
President, the Congress, and the Board of Governors of the Federal Reserve
System.”

It is obvious that the
mandate the Fed received from Congress was to implement policy that contained
or prevented inflation in the context that would increase production. The Fed was to then report on how the monetary
policy impacted the variables that describe the whole spectrum of production.

There never was a dual
mandate of “maximum employment" and inflation granted to the Fed by
Congress. It is clear “maximum
employment” is the desired results but not the mandated objective.

The history of the Fed after
the 1978 and a consideration of the “dual mandate” use since then, also shows
that Congress has never granted the Fed the employment and inflation dual
mandate. Almost immediately after the
1978 Humphrey Hawkins Amendment, Volcker simply tossed onto the academic
rubbish heap Miller’s use of the amendment – and Miller did not focus on
employment but concentrated on economic growth via an easy Fed such that it
would result in greater employment. The
results were the agony of stagflation, which in theory was never to occur, so
the 1978 act suffered immediate discrediting and seemingly proof that the
linkage of inflation and production was not understood. So the entire academic basis for the 1978 was
tossed out the window – and to many that is still its status. Volcker commented:

“… I don’t think that we have the choice
in current circumstances — the old tradeoff analysis — of buying full
employment with a little more inflation.

We found out that doesn’t work, and we are in
an economic situation in which we can’t achieve either of those objectives
immediately. We have to work toward both of them; we have to deal with
inflation. And the Federal Reserve has particular responsibilities in that
connection. “

From
then until the mid 1990s, the Fed “dual mandate” was rarely mentioned as the
Phillips Curve and the ability of the Fed to control the employment inflation
tradeoff was a risible concept. In fact
employment was dropped from consideration and it was accepted in the sense
Congress always had placed it, as a subset of production with production
analysis framed in terms of realized and potential. The rules appear where societal goals of full
employment are not considered to be within the ability of the Fed to seek. That is why all monetary policy “rules” (ironically Yellen implicitly acknowledges
this with her modified Taylor Rule, her “balanced rule” not having employment
as an explaining factor) either have only inflation or inflation and some
metric qualifying production – usually an
output gap value - as the entire useful set of factors that the Fed
can effect. Since there is no academic literature,
at least that I can find, that applies an employment variable into a “rule”, it
shows that no one at the Fed thinks they can directly impact employment. This is another indication that not only is “maximum
employment” cited as the mandate an unconstitutional legal ruse, the use of
employment in the dual mandate is a
communicative effort, or more correctly described as propaganda. Bernanke admits as much, how the fed cannot
impact employment but is in the domain of economic policy not monetary policy in one of his last speech on November 19 2013:

“….the Federal Reserve could not adopt a numerical
inflation target as its exclusive goal. Nor would it have been appropriate for
the FOMC simply to provide a fixed objective for some measure of employment or
unemployment, in parallel with an inflation objective. In contrast to
inflation, which is determined by monetary policy in the longer run, the
maximum level of employment that can be sustained over the longer run is
determined primarily by nonmonetary factors, such as demographics, the mix of
workforce skills, labor market institutions, and advances in technology.
Moreover, as these factors evolve, the maximum employment level may change over
time. Consequently, it is beyond the power of the central bank to set a
longer-run target for employment that is immutable or independent of the
underlying structure of the economy.”

This is
amazing, to me as Bernanke is almost winking and rubbing his nose and admitting
that the use of employment by the Fed is solely to fool the folks into having
the expectations the Fed seeks – ergo “forward guidance”.

The
problem now seems to be that some in the Board of Governors group, including
Yellen have come to believe that the mandate is full employment, one of a duo, and the Fed can bring about a qualified full employment status. Or she is a most audacious
liar and is cynically leaning into the Bernanke “communicative” purpose of the
ruse – no harm no foul all for a good cause – to simply expand and maintain the
newly found power of the Federal Reserve delivered to them by the crisis.

The use
of employment in the dual mandate also didn’t appear until mid 1990s, and when
hawks attacked Greenspan who bravely made a call on
productivity that allowed him to stay in relative ease throughout the 1990s,
producing the “Great Moderation” and providing the strong capital market
setting that allowed for the rise in productivity in the first place, the dual
mandate was thrown in his face to justify the Greenspan policies. It seems
the Princeton colleague to Bernanke, Alan Blinder was the first to use this
approach, defending Greenspan from the hawks when he wasnt trying to oust
Greenspan and replace him with Alan Blinder:

“As usual, let me defend the status quo. We
have a dual objective in the Federal Reserve Act now. I think it works very
well. I think the case that it is broken and needs fixing is very thin. … There
is no existing evidence — and I can’t say this too strongly — that having such
targets leads to a superior trade-off. None at all. It is not one of those
cases in which the evidence is equivocal. There is nothing that can be cited “ FOMC Minutes Jan 31 1995 Blinder

Then, perhaps
with Blinder exiled from the Fed and the dotcom bust, employment in the dual
mandate disappears from academic and Fed lexicon until the 2008 solvency event.

And even then
the Fed was slow to discover that their main purpose in life was to honor the “dual
mandate”, not even mentioning employment and mandate in the same sentence until
the September 2010 FOMC. I find this very
strange as it certainly does not sync with those who think “of course” the Fed’s
powers rest upon the long established core empowerment of the dual mandate – it
is law!

“Measures of underlying inflation are
currently at levels somewhat below those the Committee judges most consistent,
over the long run, with its mandate to promote maximum employment and price
stability” September 2010 FOMC Statement"

But even as
late as 2010 the Fed was yet to discover their constitutional bedrock of
empowerment, the obvious long standing dual mandate of “maximum employment” and
inflation. But by September, as they
started to get some heat over the startling swelling of the Fed’s balance sheet via QE I and then the start of
QE II, they had obviously switched the statutory mandate to support increased
production with “maximum employment”. By
the November 2010 FOMC, finished form had been “discovered” and the shibboleth
of dual mandate had been created with the Fed freely rewriting the Federal
Reserve Act, despite the fact that they believed that the Fed could not
directly affect employment, that employment was a nice results but since Miller
no one at the Fed thought it had much to do, if anything, with monetary policy.
Still the November 2010 Statement was the first statement of the dual mandate
claim that has been in every statement since:

“Consistent with its statutory mandate, the Committee
seeks to foster maximum employment and price stability. Currently, the
unemployment rate is elevated, and measures of underlying inflation are
somewhat low, relative to levels that the Committee judges to be consistent,
over the longer run, with its dual mandate.” November 2010 FOMC
Statement

The belief in
a “natural rate”, a Fisher rate, is the keystone to FOMC monetary theory. The level of what the natural rate is is the
subject of great debate, but almost all policy makers and analysts in the Fed
system believe in the Friedman-Phelps natural rate thesis that the natural rate
cannot have any impact on the level of employment.

So based on
the record, a read of the relevant law and the amendments, the academic use of “dual
mandate” both inside and outside the Fed since the 1978 amendment, the
widespread belief in Freidman-Phelps, and how the “dual mandate” slipped
into the FOMC Statement and when it did so (late as November 2010) – the Fed, in truth, do not believe they have a Congressional mandated objective to reach “maximum
employment” and the use of the concept of “dual mandate” is for “communicative”
purposes or to justify the greatly expanded power base.

In short, the formal use of “dual mandate”
with maximum or full employment as one of the main objectives of the Fed, is
clearly unconstitutional and a “ruse”.
Since Miller every FOMC was loath to express their objective or mandate
in terms of unemployment or employment as it was felt that it could not be
changed via monetary policy and was not the mandated task assigned to the Fed
by Congressional law.

All that
radically – and in a very risky unconstitutional way – changed on November
3, 2010.

Those who
think the dual mandate is a given, always a keystone to Fed policy and clearly
the assigned duty of the Fed by Congress simply have not read the history of the Fed,
considered the law in even a casual manner, and are naive.

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About Me

Many years of experience in being a market maker, a trader, a salesguy or portfolio manager in almost all asset classes known. Have had a high teens average career return and yet can say that I have lost more money in more asset classes than anyone I know.
My biggest curse is that not even wishing to become involved: "I see dead people.", as the kid said in the movie. I can smell a trade in the drawer or financial fraud or PL blowup miles away. Should have been with the FBI if wanted to max social utility.
Autodidact in all things math, formal education in history.